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Fiscal policy and default risk in emerging markets

  • Gabriel Cuadra
  • Juan M. Sanchez
  • Horacio Sapriza

Emerging market economies typically exhibit a procyclical fiscal policy: public expenditures rise (fall) in economic expansions (recessions), whereas tax rates rise (fall) in bad (good) times. Additionally, the business cycle of these economies is characterized by countercyclical default risk. In this paper we develop a quantitative dynamic stochastic small open economy model with incomplete markets, endogenous fiscal policy and sovereign default where public expenditures and tax rates are optimally procyclical. The model also accounts for the dynamics of other key macroeconomic variables in emerging economies.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 09-01.

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Date of creation: 2009
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Handle: RePEc:fip:fedrwp:09-01
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